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Dianetics lost public credibility on August 10 when a presentation by Hubbard before an audience of 6,000 at the Shrine Auditorium in Los Angeles failed disastrously. He introduced a woman named Sonya Bianca and told the audience that as a result of undergoing Dianetic therapy she now possessed perfect recall, only for her to forget the color of Hubbard's necktie. A large part of the audience walked out, and the debacle was publicized by popular science writer Martin Gardner. On September 3, psychologist Erich Fromm publicly derided Dianetics as a "mixture of some oversimplified truths, half truths and plain absurdities"; Fromm criticized the writing as "propagandistic" and likened it to the quack field of patent medicines. By late-1950, Hubbard's foundations were in financial crisis. Hubbard's publisher Arthur Ceppos, his longtime promoter John Campbell, and medical doctor-turned-Dianetics endorser Joseph Winter all resigned under acrimonious circumstances.
In late-1950, Hubbard began an affair with employee Barbara Klowden, prompting Sara to start her own affair with Miles Hollister. On February 23, 1951, Sara and her lover consulted with a psychiatrist about Hubbard, who advised that Sara was in grave danger and Hubbard should be institutionalized. The trio telephoned Jack Maloney, the head of the Hubbard's foundation in Elizabeth, New Jersey, to request funding for the hospitalization. Maloney informed Hubbard of the plans to institutionalize him. That night,
Hubbard and two trusted aides kidnapped Hubbard's one-year-old daughter Alexis and wife Sara and attempted unsuccessfully to find a doctor to examine Sara and declare her insane. He let Sara go but took Alexis to Cuba. Hubbard denounced Sara and her lover to the FBI, portraying them in a letter as communist infiltrators. An agent annotated his correspondence with Hubbard with the comment, "Appears mental".
On April 12, Sara's story was published in the press, leading to headlines such as "Ron Hubbard Insane, Says His Wife". Hubbard's first wife evidently saw the headlines and wrote to Sara on May 2 offering her support. "Ron is not normal... Your charges probably sound fantastic to the average person—but I've been through it—the beatings, threats on my life, all the sadistic traits you charge—twelve years of it." In June, Sara finally secured the return of her daughter by agreeing to a settlement in which she signed a statement, written by Hubbard, declaring that she had been misrepresented in the press and that she had always believed he was a "fine and brilliant man".
The Dianetics craze "burned itself out as quickly as it caught fire", and the movement appeared to be on the edge of total collapse. However, it was temporarily saved by Don Purcell, a millionaire who agreed to support a new Foundation in Wichita, Kansas. In August 1951, Hubbard published Science of Survival. In that book, Hubbard introduced such concepts as the immortal soul (or "Thetan") and past-life regressions (or "Whole Track Auditing"). The Wichita Foundation underwrote the costs of printing the book, but it recorded poor sales when first published, with only 1,250 copies of the first edition being printed. The Wichita Foundation became financially nonviable after a court ruled that it was liable for the unpaid debts of its defunct predecessor in Elizabeth, New Jersey. The ruling prompted Purcell and the other directors of the Wichita Foundation to file for voluntary bankruptcy in February 1952. Hubbard resigned immediately and accused Purcell of having been bribed by the American Medical Association to destroy Dianetics. Hubbard emptied the Wichita foundation's bank accounts, in part through forgery.
=== Pivot to Scientology ===
Having lost the rights to Dianetics, Hubbard created Scientology. At a convention in Wichita, Hubbard announced that he had discovered a new science beyond Dianetics which he called "Scientology". Whereas the goal of Dianetics had been to reach a superhuman state of "Clear", Scientology promised a chance to achieve god-like powers in a state called Operating Thetan. Hubbard introduced a device called an "electropsychometer" (or e-meter), which called for users to hold two metal cans in their hands to measure changes in skin conductivity due to variance in sweat or grip. In 1906, Swiss psychoanalyst Carl Jung had famously used such a device in a study of word association. Rather than a mundane biofeedback device, Hubbard presented the e-meter as having "an almost mystical power to reveal an individual's innermost thoughts".
Hubbard married a staff member, 20-year-old Mary Sue Whipp, and the pair moved to Phoenix, Arizona. Hubbard was joined by his 18-year-old son Nibs, who had become a Scientology staff member and "professor". Scientology was organized in a different way from the decentralized Dianetics movement — The Hubbard Association of Scientologists (HAS) was the only official Scientology organization. Branches or "orgs" were organized as franchises, rather like a fast food restaurant chain. Each franchise holder was required to pay ten percent of income to Hubbard's central organization. In July, Hubbard published "What to Audit" (later re-titled Scientology: A History of Man), which taught everyone has subconscious traumatic memories of their past lives as clams, sloths, and cavemen which cause neuroses and health problems. In November 1952, Hubbard published Scientology 8-80, followed up in December with Scientology 8-8008, which argued that the physical universe is the creation of the mind.